Doomed by Dixons – Carphone defects

£3.8 billion merger would create the UK’s largest electronics retailer with turnover of almost £11 billion

‘If you can’t beat them, join them’ was the message from Carphone Warehouse last week, as its proposed £3.8 billion joint-venture merger with Dixons Retail Group moved a step closer.

The deal, which will see the creation of the UK’s largest electronics retailer, with combined turnover of close to £11 billion – is Carphone’s second attempt to break in to the wider UK electronics market, having failed in attempts with former joint-venture partner Best Buy in 2010.

Ironically, according to Carphone Warehouse UK and Ireland chief executive Graham Stapleton, it was Dixons, through its retail brands Currys and PC World, that doomed CPW/BestBuy to failure – resulting in all 11 of its 40,000 square foot “big box” stores closing in less than two years.

The short-lived venture, which lost Carphone “tens of millions”, was based on the same principles to that of Dixons – exploiting the growing trend of “connected devices” beyond simply mobile and tablets, which we’ll come to later.

Valuable lessons
Stapleton insists Carphone has learned strong lessons from the Best Buy failure and is well equipped for the new venture. “We created a very, very successful business with Best Buy in America,” he said. “The challenge came with Best Buy bringing their big box business over to the UK and Europe. To be frank, the competition was probably better and more robust than we thought and that was very much around Dixons. They probably created part of the reasons why it wasn’t successful because they were such a good competitor and that was probably another reason why the merger makes sense.

“It might not have been successful but it was an incredibly good training ground for this. We know what works and have learned some of the lessons and that puts us in good stead having done it before.”

Connected world
As mentioned, the reasoning (in public) behind the deal, which is still subject to shareholder approval on both sides, centres heavily around exploiting the growing trends of connectivity on multiple devices, both in and outside of the home. And with good reason. Analyst firm Gartner predicts that 26 billion devices (excluding PCs, tablets and smartphones) will be connected globally to the internet by 2020 – whilst Cisco puts this figure closer to 50 billion. That’s an average of eight connected devices per person on the planet.

Examples include TVs and cameras, as well as more unconventional appliances such as ovens, washing machines, central heating, microwaves, dishwashers and even fridge freezers – with the smartphone acting as the remote control. Dixons chief executive Sebastian James described the deal as “a true merger” and one based on “strategic logic”, while Dunstone said the combined firm would be a “new retailer for the digital age”.

The theory is that Dixons has the expertise and floor space (Currys and PC World) to sell these appliances, while Carphone can supply the connectivity to them – creating a “one-stop” shopping experience for the consumer.

“The turnover of the combined business is around £10.6 billion, so it creates a very big sales retailer,” said Stapleton. “If you are able to bring that sort of scale to the market you are going to have efficiencies across the whole piece. That in effect means customers get better propositions and that’s what we are here to do. It’s gonna be big.

“If you bring the vast range of products Dixons sells combined with our connectivity and then think of the way the world is changing in to a very much more internet of things (see box out below), this merger could be fantastic news for customers, and generally, when you have two businesses coming together for customer reasons particularly in the retail space, you have a better chance of success.

“We want to bring the opportunity to connect lots of different products in the home and on the go together so people can really see those opportunities and potential for them.

“The other big difference is how we service and look after customers through their lifetime. For us it’s two phases; firstly, showing customers the possibility around connectivity, and secondly, simplifying the proposition and helping them through their journey.”

Falling revenues
However, many analysts and industry commentators are more sceptical, suggesting the merger is all about saving cash – expected to reach around £80 million by 2017/18.

Market conditions are tough. Online sales and competition on prices have been a key to the demise in electronics retail space in recent years, with its biggest victim to date being that of rival Comet, which went bust in December 2012, shutting all 236 stores with 6,500 staff losing their jobs.

Dixons has cut its losses steadily in recent years, falling from £177.8 million in 2011 to £50.9 million last year (see graphic). Some in the industry suggest from a financial perspective, the need to merge was far greater from Dixons.

However, Ovum principal analyst Steven Hartley disagreed, suggesting the “walls are closing in” on independent retailers as a result of operator strategic changes.

Away from the falling margins and commissions earned on airtime, operators are, again, showing a growing desire to distance themselves from the indirect consumer space.

Vodafone and Three have invested heavily in their retail outlets in recent years, with the latter removing itself from the indirect channel altogether. O2 has removed itself from Phones 4u stores – whilst EE is currently undergoing an indirect review of its consumer partners, which includes Carphone Warehouse. Vodafone previously axed Carphone in 2007 before returning in 2009.

Shrinking market
“You can certainly see how they’ve folded into each others’ arms,” said Hartley. “If you think of the squeeze on the consumer electronics market on one side and the squeeze on Carphone’s traditional high street phone business, it makes total sense. Do companies ever merge from a position of strength?

“Carphone wasn’t struggling but certainly the opportunities are shrinking. From an operator perspective, they’ve been wanting to push more sales through their own branded channels, online or retail. They’ll claim they get better RPU and loyalty through customers that come through that channel than the independents. The operators don’t really want to go down that channel.”

Retail Verdict analyst Matthew Rubin agreed, suggesting the “internet of things” line, whilst not irrelevant, is most likely down the list of reasons for the deal – and is attempting to appease concerned shareholders. However, the buying power as a joint venture will be hugely beneficial in competing with online players.

“To me, it’s just a simple business decision about making it more efficient and having two big electrical companies working together. It gives them a lot of buying power, closes a lot of their back office staff and they can cut back staff there. In actual effect of trying to bring together this end-to-end connected world, I’m not so sure.

“You’re not going to have a 3G-enabled fridge – its going to go through WiFi if anything. I think it’s a lot of marketing gimmickry, possibly to sell it to the shareholders, to make it sound better than it actually is, but it’s not necessarily a bad thing for those two to combine. It will help them.”

He added: “ The outlook in electricals is a lot rosier now, so having the combined forces to bring about efficiencies is more powerful with the market growing.

CPW brand is safe
“It also gives them more leeway to fight against online players like Amazon, so they [Dixons] have done really well to bring their prices in line. Obviously that will cut back on their margins so they need another way to make themselves more competitive.”

One thing that will remain for the short to mid-term will be the Carphone Warehouse, Currys and PC World names – with no plans currently in place to expose “Dixons Carphone” as publicly facing.

Stapleton (pictured) said brand awareness in the UK of Carphone Warehouse, PC World and Currys was in excess of 95 per cent, something which would be a risk should it make wholesale changes to.

An existing contract with Phones 4u, which currently occupies 160 through concession stores (stores within a store) will be honoured until mid-2015 when it expires.

Stapleton said no decisions had been taken on how the store format will look, and whether the Carphone Warehouse brand will be used in a similar way to that of Phones 4u.

Currys and PC World stores, often found on retail parks, are traditionally much larger than Carphone stores typically found on the high street. Based on this, Currys and PC World stores are the more likely to be adapted to offering a great mobile presence, rather than Carphone offering home applicances.

Carphone did introduce its Wireless World format stores in 2008, extending its reach from just mobile devices to offer laptops, games consoles and connected TV’s – describing them as “small box” stores.

“I’m sure there will be mobile stores within stores,” said Stapleton. “What they will be branded I’ve no idea. Obviously there is a contract with Phones 4u at present. When that comes to an end, whether it’s a Carphone branded store in store or a Curry’s Mobile store, we haven’t made a decision on that.

“What I can confirm is that in the short to mid-term there are no plans to change the Carphone Warehouse brand. Currys, PC World and Carphone have 95 per cent awareness in their markets so even if you were to change the brand you’d have to do it in a carefully and considered way because a lot of customers know the brand and have a lot of equity, therefore you have to be very careful what you change and when.”